HEADING TOWARDS JUNE FOMC MEETING

In this edition of Central Bank Watch, we’ll review the speeches made over the past week by various Federal Reserve policymakers, including the Fed Chair himself. The June FOMC meeting is under two weeks away, and it’s becoming evident that policymakers are beginning to lay the foundation for initial QE tapering efforts.

TALKING ABOUT TALKING ABOUT TAPERING

The Federal Reserve will be keeping rates low and stimulus flowing for the foreseeable future. Even though interest rates hikes aren’t coming anytime soon, the timing of when the winddown of the Fed’s asset purchase program will begin will be a focal point for financial markets over the coming months.

May 27 – Kaplan (Dallas president) says that “Policymakers should be cognizant of a range of supply factors that may currently be weighing on employment. These factors may not be particularly susceptible to monetary policy.” This dovish call was underscored when he later said “you don’t want to be so preemptive that you choke off the recovery.”

June 1 – Bullard (St. Louis president) says “even though it’s a booming economy and GDP is growing leaps and bounds, I’m not sure employment is going to follow.”

Brainard (Fed governor) says that there are two-sided risks to the economy, as the recovery surges ahead even though millions of people remain unemployed as a result of the pandemic.

June 2 – Barkin (Richmond president) says that the “data don’t yet show many rebounds in overall wage growth,” suggesting that anecdotes from business contacts about labor shortages could ultimately result in wage growth.

Harker (Philadelphia president) hints at tapering, saying he thinks “it is appropriate for us to slowly, carefully move back on our purchases at the appropriate time.”

The Federal Reserve makes an announcement that it will gradually begin to sell its portfolio of approximately $13.6 billion of corporate debt purchased during the pandemic.

The Beige Book summarizes an accelerating pace of growth for the US economy, while businesses are struggling with rising costs and a lack of available labor at current prevailing wages.

June 3 – Bullard says that the US labor market might be tighter than what is suggested by the headline unemployment rate (U3).

Clarida (Fed Vice Chair) notes in a research paper that the pandemic efforts by the US federal government and the Federal Reserve “provided crucial support to the economy in 2020 and are continuing to contribute to what is expected to be a robust economic recovery in 2021.”

FEDERAL RESERVE INTEREST RATE EXPECTATIONS (JUNE 3, 2021) (TABLE 1)

True, as has been the case for weeks, Fed funds futures are pricing in around a 10% chance of a change in Fed rates through January 2022. But beneath the surface, there has been seemingly scary high volumes across the Fed’s open markets desk, suggesting that liquidity is being drained from the system. For now, without a corresponding rise in US Treasury yields, we’ve seen the start of a tantrumless taper, if you will.

If you haven’t read the note, The Scary Fed Number Everyone is Talking About, you might be interested in doing so to get more context about where the Fed currently stands.

TAPER TIMELINE

There’s been a lot of conversation around the perceived timeline of the Federal Reserve’s plan to taper its asset purchases, a discussion likely to be revived regardless of the outcome of the May US NFP report. This is in part thanks to heightened activity across the Fed’s open market desk (with respect to reverse repos) as well as news that the Fed is winding down its corporate credit portfolio.

In consideration of these facts, it appears that market participants have the taper timeline priced as such:

• June through September 2021 = taper talk
• September 2021 = indication taper is coming
• December 2021 = taper targets announced
• January 2022 = taper begins
• September/December 2022 = taper ends
• March 2023/June 2023 = first rate hike (3-6 months post-end of taper)

Broadly speaking, even if it’s an insignificant amount of funds, the Fed winding down is pandemic credit portfolio is completely sensible given the fact that the RRP facility has been tapped so frequently recently. The system is flush with cash; companies are well capitalized. Markets don't need to worry about the 'tides of insolvency dragging the illiquid out to sea.'

IG CLIENT SENTIMENT INDEX: USD/JPY RATE FORECAST (JUNE 3, 2021) (CHART 1)

USD/JPY: Retail trader data shows 50.77% of traders are net-long with the ratio of traders long to short at 1.03 to 1. The number of traders net-long is 6.65% lower than yesterday and 8.12% lower from last week, while the number of traders net-short is 5.53% lower than yesterday and 12.39% higher from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests USD/JPY prices may continue to fall.

Yet traders are less net-long than yesterday and compared with last week. Recent changes in sentiment warn that the current USD/JPY price trend may soon reverse higher despite the fact traders remain net-long.